Demographic changes threaten security of Social Security

By M. Ray Perryman

Published 10:07 am, Monday, September 14, 2015

August marked the 80th anniversary of Social Security. President Franklin D. Roosevelt signed the Social Security Act into law in August 1935, with the goal of giving “some measure of protection to the average citizen and to his family against the loss of a job and against poverty-ridden old age.”

Since that time, some $15.2 trillion in benefits have been paid. In June 2015, more than 64.7 million people received Social Security payments (including Supplemental Security Income). The majority of them (about 43.5 million) were age 65 or older, while 14.3 million were disabled (under age 65). A total of $72.7 billion dollars was paid out, with an average monthly benefit of $1,221.

Social Security came about in the midst of the Great Depression. After a decade of relatively sustained prosperity and optimism during the 1920s, the stock market collapsed in 1929. The next few years would bring a banking panic and a severe drought that turned the Great Plains into a “dust bowl.” Corporate bankruptcies, foreclosures, and closings combined to create unemployment rates in the 20 percent to 30 percent range. Half of the persons age 65 and over were dependent on others for their support, with approximately one in six receiving public charity. Moreover, the combined calamity in equity markets and financial institutions had claimed most or all of the savings of many. The goal of Social Security was to assure that future generations of retirees would not face a fate of poverty and dependence.

Social Security was essentially a “pay-as-you-go” system at the outset, with collections from workers and employers used to make payments. From a conceptual standpoint, Social Security originally benefited from a phenomenon which has been called the “biological rate of interest,” with approximately 40 people working for every eligible recipient. Most people did not live to retirement age, and those that did had a relatively short life expectancy beyond that point. In addition, the vast majority of women did not work outside the home and were therefore not eligible for old-age benefits. Thus, the taxes could be kept very low (2 percent applied to low base income levels at the outset), and early recipients received an average rate of return of approximately 25 percent on their contributions.

Since those early days, much has changed, and many now worry (with good cause) about the program’s sustainability. Dependents and survivors were added to the program in 1939, and disability insurance was added in 1956. Benefit increases have occurred on many occasions, and payments are now indexed to the cost of living. (Medicare has also been implemented, but it relies on a separate tax levy.) The biggest changes, however, have been demographic and societal in nature.

Advances in medical technology have extended life expectancy considerably and will continue to do so in the future. The result is more people becoming beneficiaries and collecting payments for a longer period of time. The dynamics of the Baby Boom also are affecting both collections and payments. As the large Baby Boomer generation (those born in the high birth rate yeas from 1946 through 1964) entered the workforce, female participation in the workforce was also rising. The result was a large group of people to support retirees and others in the Social Security system.

However, the tide is now beginning to turn. The oldest Boomers began reaching retirement age in large numbers in 2011, and the fundamental demographics that made the system work initially will begin to accelerate in the opposite direction. Instead of 40 workers supporting each Social Security beneficiary, we may ultimately reach a level of only two workers per recipient.

The threats regarding future viability have led to periodic tweaking of the system. One of the most significant changes was to move away from the “pay-as-you-go” philosophy and begin accumulating surpluses each year into a trust fund. The fund has been growing for a number of years and now stands at about $2.8 trillion. Income into the program from Social Security taxes, income taxes on benefits and interest is estimated to total of $884 billion this year, while payments and administration are expected to total $859 billion, leading to another $25 billion into the trust fund. However, we are nearing the end of the surplus years.

Around 2019, the system is projected to begin to pay out more than it collects in income as Baby Boomers reach retirement and the growth rate of the workforce declines. Interest earnings will make up the shortfall for a few years, but then it will be necessary to dip into the principal balance of the trust fund. By 2034, the available funds are expected to be completely exhausted. Without the trust fund, amounts coming into the program fund only about 79 percent of benefits.

Needless to say, a more than 20 percent drop in Social Security payments is to be avoided. It is also clear that meaningful reform should be implemented sooner rather than later. What is more difficult is determining the nature of reform. Over time, various potential solutions have been debated ranging from partial privatization to higher taxes to more stringent income tests and even higher retirement ages. The ultimate solution will probably involve a combination of these and other measures. No solution will be easy, but every year we wait only makes the situation worse. We can only hope that bipartisan agreement in Washington can be reached well in advance of the crisis we all know is coming.

Dr. M. Ray Perryman is President and Chief Executive Officer of The Perryman Group (www.perrymangroup.com). He also serves as Institute Distinguished Professor of Economic Theory and Method at the International Institute for Advanced Studies.